Mary Holm: Cost of debt usually tops savings

The desire for Christmas gifts could mean a compromise between repayments and savings. Photo / Thinkstock

We arrived here in New Zealand about seven years ago. We have a personal loan of $18,000-plus, a timeshare and no credit card debt.

We have two cars that are paid off. We intend to sell one for around $3000 and several surplus items of value as well, in order to pay off debt.

Should we as a couple save some money for Christmas expenses, etc, every month or just completely pay all extra money on debt reduction?

It's a great idea to get rid of debt. It puts you in a much stronger financial position.

When deciding whether to save or repay loans, you should compare the interest rate charged on the loans with the interest or other returns you expect to make on your savings, after tax and any fees.

In most cases - and probably in your case - the interest on the debt is higher, so it's smarter to stop paying that interest as soon as possible. That means forgetting about Christmas and going full steam ahead with debt repayment.

However, there's also a psychological element to this.

What's going to happen at Christmas time? I hope that, in the circumstances, you'll try to reduce Christmas spending. But life is for living, and it's inevitable that you'll indulge in a few gifts and treats.

If you can't cover them all with current income, you'll end up with your debt rising again. Will that discourage you, perhaps to the point that you give up your debt repayment mission?

If that's a possibility, let's compromise. How about concentrating on debt repayment until August or September, and then concentrating on Christmas saving for a few months - while promising yourselves that come December you will spend only as much as those savings allow?

The difference between the interest paid on your debt and the interest earned on your Christmas savings over just two or three months won't have all that much impact on your financial situation. If saving for Christmas keeps you on the debt repayment path, it will be well worth it.

Note that I said above that interest on debt is usually higher than returns earned on savings. The most common exception is student loans. Read on.

Student loans I

In a recent column you mentioned: "Because [student] loans are interest-free, it's best to make just the compulsory repayments and contribute to KiwiSaver - until you get within three years of paying off the loan with compulsory payments. At that point, you should repay the loan as soon as you can, to make the most of the student loan repayment bonus."

Is there some significance to the last three years of student loan payments? As far as I can see the repayment bonus applies at any point while you have the loan and make voluntary payments over the threshold.

There's no particular significance to the three years. It's just that when an actuary crunched the numbers, he found that about three years from your final payoff date, it's financially efficient to make the most of the student loan repayment bonus. Before then, it's better to leave your savings in an account earning interest.

For the benefit of others, the student loan repayment bonus works as follows: if you make extra payments of $500 or more a year above your compulsory repayments, you get a bonus of 10 per cent of the extra amount.

For example, if you pay $900 extra, it's treated as if you had paid $990 extra. For more information, go to tinyurl.com/repayloan.

We should acknowledge that some people want to get rid of their student loans as quickly as possible, even if that's not financially optimal. And that's fair enough. If you feel that way, go ahead and repay extra whenever you have spare money. You'll still benefit from the bonus, as long as you make the extra payments at least $500 a year.

By the way, you and other students should keep up with upcoming changes that will "improve the way student loans are managed, repaid and administered", says the Government.

Most of the changes will take effect from this coming April, with a few starting a year later. They include the introduction of an annual $40 admin fee. For more info, see tinyurl.com/sloan03

Student loans II

I'm a foolhardy Kiwi living overseas with a student debt, and would like to know a little more about my situation.

I understand the scoundrel National Government is charging me a competitive interest rate on the student loan. I think this is an abuse of power by the current government, but I won't get into that here.

Could you help me find out if there are any implications to my being overseas, besides the interest being charged on my loan? And if I ignore the loan, say for five years, or stay outside of the country for five years, will it eventually be wiped?

Are the rules different if I'm living in, say, Australia, or the UK, or Europe?

I am studying in the coming year, so that will wipe the interest for that year. But I'm not planning on returning any time soon, and don't want to be unfairly burdened when I return home.

My loan balance is around $16,000. How much interest am I being charged per financial year? And does making small payments help reduce some of the charges being made on my loan? Any other tips and advice? Many thanks.

I agree, let's not get into whether a government is a scoundrel for charging interest to a graduate who has been educated in New Zealand - using considerable taxpayer subsidies as well as an interest-free loan - but is now using that education elsewhere. You might not like what I have to say!

On to your questions. When a student with a loan goes overseas for more than six months, they are charged interest, currently at 6.6 per cent a year, starting from the day after they leave New Zealand. The same rules apply whether they are in Australia or any other country.

How much interest are you being charged on a $16,000 loan? Interest is added to your balance once a year, on March 31, but it's calculated daily. If you were to pay nothing, a year from now the balance would be $17,056, and then interest would be charged on that amount, and so on. Making payments, big or small, will all help to keep interest charges down.

While away, you can take a repayment holiday for up to three years, which means you're not obliged to make any compulsory repayments. You automatically got that holiday from the day after you left New Zealand. But - and this is important - the interest will still be applied, and compounding. So it's better to keep making payments.

In any case, if you are still away after three years, the repayment holiday ends. What's more, says Inland Revenue, "the Government announced in the 2011 Budget that it intends to reduce the repayment holiday to one year from April 1 this year. From this date you would need to apply to Inland Revenue to receive the holiday, rather than it being given automatically. Borrowers already overseas and on a repayment holiday will also have their holiday reduced."

This change is "subject to legislation". You can keep up to date at tinyurl.com/sloan03

At the end of your repayment holiday, you'll have to start making repayments twice a year, in two equal instalments on September 30 and March 31. If you owe less than $1000, you have to repay the whole lot. If you owe $1000 to $15,000, you have to repay $1000 a year. If you owe $15,000 to $30,000 it's $2000 a year. If you owe more than $30,000, it's $3000 a year.

In your case, the minimum payments are $2000 a year, in two $1000 instalments. But once your balance falls below $15,000 (as at March 31), that will drop to two $500 instalments. The decrease sounds helpful, but it means that - assuming you stay overseas - it will take more than 35 years to get rid of your debt, according to the Student Loan Repayment Calculator on www.ird.govt.nz.

I strongly suggest you keep up the $1000 instalments. It makes a huge difference. For example, when your loan is at $14,000, if you repay $1000 every September and March, the calculator shows that you will repay the loan in 8.5 years, and save more than $16,000 in interest. You will also benefit from the student loan repayment bonus described in the above Q&A, saving you $850.

What if you make no payments at all? Ignoring the loan or staying out of the country is not clever. Loans are not wiped. It's the opposite - penalties are added.

Furthermore, "Inland Revenue is actively contacting overseas-based borrowers who have defaulted on their student loan repayments and is taking legal action against borrowers who have ignored their obligations," says a spokesperson.

"For those overseas-based borrowers who are not meeting their obligations, it is important that they realise that they have gone away but their loan hasn't."

Ready for more bad news? I'm afraid that just because you plan to study overseas, that doesn't mean the interest stops.

That applies only if the main reason you left New Zealand was to study full-time overseas.

And even then, you have to be "enrolled with a New Zealand education provider and on a formal exchange, or studying at post-graduate level because your course is not offered in New Zealand", says Inland Revenue. That doesn't sound like you. For more on this, go to tinyurl.com/sloan1

There's lots more about overseas student loan borrowers at tinyurl.com/sloan02, and it's easy to understand. Alternatively, you can ask Inland Revenue for help: "If a borrower needs assistance or is facing financial difficulty, then they need to contact us.

"We can assist in setting up payment plans that will enable borrowers to get back on track and make their loans more manageable," says the spokesperson.

I urge you to get your repayments going now.

You don't need a big worry hanging over your OE - possibly even a fear of coming home. It's just not worth it.

Good point

I am a long-time fan of your column and the level-headed advice you dispense within. So please take this as constructive criticism: Are you ever able to fully concede a point?

Mary Holm is a freelance journalist, part-time university lecturer, member of the Financial Markets Authority board, director of the Banking Ombudsman Scheme, seminar presenter and bestselling author on personal finance. Her website is www.maryholm.com. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary's advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to mary@maryholm.com or Money Column, Business Herald, PO Box 32, Auckland. Letters should not exceed 200 words. We won't publish your name. Please provide a (preferably daytime) phone number. Sorry, but Mary cannot answer all questions, correspond directly with readers, or give financial advice.